What are commodities?
A natural good typically used as raw material, there are four basic categories of commodities:
- Energy – including crude oil, heating oil, natural gas and gasoline
- Metals – including gold, silver, platinum and copper
- Agricultural – including corn, soybeans, wheat, rice, cocoa, coffee, cotton and sugar
- Livestock and meat
All traded on exchanges, the prices of these commodities can fluctuate greatly on a daily basis due to natural disasters, geopolitical crises and simple supply and demand.
It’s possible to trade the physical commodity, but they’re typically traded as futures. This gives the owner of the futures contract the right to take delivery of a given quantity of the commodity. Future contracts are also traded on commodity exchanges and can be used to speculate on the changing price of the underlying commodity.
There are no points in commodity futures trading, but commodity CFDs linked to futures prices have points relating to the spread between the ask and bid price of the CFD contract. These points vary based on the commodity CFD being traded and are similar to a broker’s commission   , as they get to keep the points. The value of points vary based on the value of the CFD and the size of the contract.
The difference between the ask price and the bid price – or the price of purchasing a contract versus what you’d get for selling it – is the spread. Spreads vary from one commodity to the next and even based on the time of day, as less liquid trading conditions typically lead to larger spreads. Before reports affecting a commodities are released, spreads can get larger too.
As commodities are traded as future contracts, they always have an expiration date. It varies depending on the commodities, but the contract month usually ends on the third Friday of the month before the futures month. Always check your contract to make sure.
Because investors have the chance to sell the contract before the expiration date, most commodities drop in volume and volatility increases as it gets closer.
Traders have a 10-18 day period before the initial expiration date to purchase the same commodity, but with a later expiration date.
How a commodity trade works
You think the price of platinum will increase in the coming months. You could buy physical platinum, but that would be cumbersome. Instead you purchase platinum CFDs, which are priced based on underlying platinum futures contracts. This means you don’t have to physically store any platinum and you can use leverage to control a far greater amount of platinum, increasing your profit if the price of platinum increases.
Platinum is quoted at $1,199.50 to $1,200. The second price is the ask price you need to pay to purchase a long position. You’re bullish on platinum, so you purchase a contract for 10 ounces at the ask prices, representing $12,000 worth of platinum. If the margin on your account is 5%, you need $600 of equity or available margin for this purchase.
A month later, platinum is quoted at $1,249.50 to $1,250. You close your contract, selling at the bid price of $1,249.50. The value of the platinum controlled by your position has increased from $12,000 to $12,495 – an increase of $495. You have to pay the rollover fees for the $600 you borrowed during the month, but it’s likely that you’ll profit more than 75% on your trade.
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